Refinancing your car — or changing the terms of your vehicle debt by taking out a new loan — can allow you to take advantage of lower auto loan rates and save money on your monthly payments. This does have some drawbacks, though, like the potential of dinging your credit: an important record that can impact your chances of being approved for everything from cell phone contracts to apartments.
When you refinance a loan, you take out a new loan with more favorable terms to pay off the remaining balance on your existing loan. You may be able to score a lower interest rate or different repayment period. The goal of refinancing is to make it easier to meet your loan obligations.
If you want to refinance, it’s crucial to weigh the pros and cons of doing so.
Does refinancing your car hurt your credit?
Before you make the decision to go through the auto loan refinancing process, consider the consequences. Refinancing your car can damage your credit. However, these effects on your credit score are temporary and usually minimal.
Because of this, if you plan on applying for a mortgage or another significant loan soon, it might be worth holding off on refinancing your car.
How does refinancing a car affect your credit?
Refinancing your auto loan can affect your credit score both positively and negatively, depending on your financial situation. Credit inquiries will likely lower your credit score, for example, but your ability to make timely car payments thanks to refinancing can improve it.
Credit inquiries and their impact
When you apply for a new loan, the lender in question typically views your credit report in order to evaluate you as a potential borrower. Certain types of credit checks, called “hard inquiries,” can temporarily bring down your credit score by a small amount. Generally, repeated hard inquiries bring down your credit score by five points or less.
Applying for many lines of new credit quickly can indicate that someone is a higher credit risk because it can suggest possible financial irresponsibility. That’s why your credit score dips temporarily when you allow multiple hard inquiries in a short period of time. Hard inquiries usually stay on your credit report for up to two years.
Timely payments and reduced debt
However, refinancing also has the potential to increase your credit score in the long term. If refinancing helps you make timely payments and regularly reduce your debt, your credit can improve.
That’s because payment history is the most significant contributor to your FICO credit score, at 35%. This factor takes into consideration whether you have regularly made loan payments on time and kept up with all of your credit responsibilities. Refinancing often helps people improve this part of their credit score by making it easier for them to make their loan payments on time every month. Because refinancing typically gives you a lower monthly loan payment, you can free up space in your budget and (hopefully) be less likely to make late payments.
Changes in credit utilization and loan history
Another key component of your credit score is the length of your credit history, accounting for 15% of your total score. Generally, having a long credit history and well-established accounts is beneficial for your credit score. When you refinance your loan, the average age of your credit accounts will go down because you’ll be opening a new loan.
The effect refinancing will have on your credit score depends on how many other credit accounts you have open and how old they are. Over time, the drop in your credit score from bringing down the average age of all your credit accounts will decrease.
Your credit utilization rate, or the percentage of your total credit you’re currently using, is also relevant here. Because refinancing often makes it easier to pay off your loan faster by reducing your monthly payments, your credit utilization may go down after refinancing. A lower credit utilization rate can improve your credit and make you appear more trustworthy to lenders.
What to consider before refinancing a car
When you’re thinking about refinancing your car, there are many factors to consider. Evaluate them carefully to figure out the right option for you.
Weigh the potential benefits and drawbacks of auto refinancing
As with any other financial decision, you should weigh the benefits of refinancing against the potential drawbacks (and literal costs) before drawing a final conclusion. Some would-be perks of auto refinancing, such as lowering your auto loan interest rate and bringing down your monthly payments, are significant. However, depending on your individual situation, they may not outweigh the downsides.
If you've already paid off most of your current loan balance, for example, you may not save much money by refinancing to a lower rate. Because lenders often structure loans to front-load the interest payments, refinancing toward the end of your loan is unlikely to save you much on interest payments.
Another drawback of auto refinancing, as mentioned, is the effect on your credit. If you are planning to apply for a large loan soon, incurring the damage refinancing temporarily causes to your credit may not be worthwhile, as you could hurt your chances of being approved for favorable interest rates due to your decreased credit score.
Assess your current financial situation and goals
Even if refinancing an auto loan is suitable for someone else, it might not be right for you. Loan decisions are highly personal and depend on your financial situation and goals.
For instance, if you’re struggling to make your current payments, refinancing your loan may offer a way to make your monthly payments more affordable. You can refinance your loan for a longer loan term so that you pay a lower amount each month. It will take longer to pay off the new loan, but that may be worthwhile if it allows you to make all your payments on time.
Refinancing your auto loan isn’t an isolated decision — it’s connected to the rest of your financial situation and goals. Look over your budget and consider what you want your finances to look like before making a decision about refinancing. The best auto refinance loans will improve your financial outlook with minimal setbacks.
Understand the costs and fees associated with car refinancing
Damage to your credit isn’t the only thing you have to worry about when refinancing your vehicle. You may also need to pay fees and other associated costs.
Generally, lenders charge an application fee whenever you apply for a new loan, like you technically are when refinancing. Application fees vary but average about $150. Even if your lender waives this fee, they may still charge origination fees for processing your loan, which average 1% to 2% of the loan amount. Depending on how many loan applications you fill out, these fees could add up quickly.
You may also need to pay a title transfer fee, depending on the state. Some states charge you to move your vehicle's title from your current lender to your new lender (assuming you refinance with a different lender).
Your previous lender may also charge you an early termination fee for closing your loan early. Look at your loan terms to see if this fee applies to you. If you’re refinancing because you’re struggling to make payments on time, be aware that your lender may charge a late payment fee for any payments after their due dates.
Tips for refinancing a car without hurting your credit
If you want to refinance your auto loan without hurting your credit, there are some steps you can take to limit the damage. Actions like getting pre-qualified for auto loans before applying and continually making on-time payments will help protect your credit when refinancing.
Consolidate credit inquiries
Rather than applying for each attractive loan offer as you find it, complete your search before making any applications. Spend some time shopping around to find all the loan offers you might want to apply for and make a list of them. Then, apply for all of these loans within a 14-day window.
Applying for all your loans within two weeks will likely consolidate the hard inquiries into your credit. Most credit scoring models will treat multiple inquiries of the same type that occur within a short period as a single inquiry, which can limit the harm to your credit.
Get pre-qualified before you apply
Before submitting any official applications, try to get pre-qualified for the auto refinancing loans you want. The pre-qualification process allows you to learn more about the potential terms of your loan without experiencing any hard inquiries. Pre-qualification can also help you eliminate some loan options that aren’t right for you. Getting pre-qualified is part of how to refinance a car without damaging your credit.
Apply for pre-qualification with the lenders you’re considering for your car loan refinancing. You’ll likely need to provide information like your employment and income details, your driver’s license number and your current debt obligations. The lenders will perform a soft inquiry into your credit and return a decision on whether you pre-qualify for a loan.
Keep making on-time payments
Paying your bills on time is the best thing you can do to protect and improve your credit. Each month, your payment history will improve. As your payment history steadily gets better, your credit score should, too, because payment history is the most significant factor in a credit score.
Build positive credit history post-financing
Beyond making on-time payments, you should take other steps to build a positive credit history after refinancing your auto loan. For example, try to avoid applying for additional new loans for a little while so you can increase the average age of your credit accounts. Ask for a credit limit increase on some of your other accounts to improve your credit utilization rate. Avoid refinancing your auto loan more than once because doing so can damage your credit history more each time.
Diversify your credit mix
Though credit mix is tied for the smallest contributor to your FICO credit score at 10%, it’s still an essential factor to consider. Credit mix refers to the variety of accounts you have open. For example, someone with two credit cards and no other loans does not have a credit mix as strong as someone with a mortgage, a car loan, credit cards and a student loan. Protect your credit while refinancing your auto loan by making sure you have a good variety of credit account types.
What credit score is needed to refinance a car?
There is no general credit score requirement to refinance a car, as each lender can set their own conditions. However, most lenders will want you to have a quote-unquote “good” credit score, at least, to approve your refinance auto loan. A credit score of 670 or more will significantly increase the odds that auto lenders will approve your refinance.
If you have a credit score of 669 or less, you may still be able to refinance your auto loan. One option is to take steps to strengthen your credit and wait to refinance until your credit score improves. Another option is to look for lenders who specifically offer auto-refinancing loans to those with “fair” or “poor” credit.
How much does your credit score drop when you refinance your car?
One of the consequences of refinancing your car is that it will temporarily hurt your credit score. But how much will your score drop? You can expect your credit score to go down by five to 10 points when you refinance, but this change is not permanent.
If you apply for many loans and receive many hard inquiries, your credit could take a bigger hit, but the effect will still go away after a year at most.
Summary of Money's guide to whether refinancing your car can hurt your credit
Refinancing your car can hurt your credit, but the damage to your score is generally minimal and will go away quickly. Hard inquiries from the loan application process and bringing down the average age of your credit accounts both can hurt your score when you refinance.
If you’re considering refinancing your auto loan, you’ll have to weigh the temporary damage to your credit against benefits such as lowering your monthly loan payment and making it easier to pay on time. Refinancing may be right for some people, while others are better off sticking with their original loan terms.